* State banks vet loans more, stop issuing L/Cs in some cases
* Iron ore traders told to secure customers, put higher margins for L/Cs
* Moves may weaken iron ore prices which hit 21-month low on June 16
By Ruby Lian and Fayen Wong
SHANGHAI, June 20 Chinese iron ore traders are being starved of credit by banks reining in loan approvals and curbing letters of credit, industry sources and bankers say, as a clampdown on financing deals in the world's top consumer of commodities gathers force.
The moves come after China's banking regulator has urged more checks on iron ore financing deals to cut default risks and amid an official probe into a suspected metal financing fraud in Qingdao port. They also come as the steelmaking raw material's prices have tumbled and port inventories are near record levels.
The funding squeeze may force small traders to sell their stocks and pressure already weak prices. Iron ore .IO62-CNI=SI has tumbled nearly 33 percent this year, hitting a 21-month low below $90 a tonne on June 16, stoking banks' concern that smaller traders may fail to repay trade loans.
"Tighter credit will exacerbate the oversupply situation in the market and will send iron ore prices even lower. The next level I'm looking at is $80," said Helen Lau, senior mining analyst at UOB-Kay Hian Securities in Hong Kong.
The Qingdao port investigation further underscores lenders' jitters over commodities financing. While the probe is centered on deals involving copper and aluminium, it could spread to iron ore, industry sources say.
Chinese banks, the major lenders to the iron ore trade, have over the past two months raised their scrutiny of iron ore financing across the country, including in Shandong - one of China's top trading hubs for the raw material - financial centre Shanghai and top steel-producing Hebei province, traders said.
Local branches of Bank of China (BOC) in Shandong province, for instance, have been required to submit all requests for issuing L/Cs to the provincial-level office for approval, while the provincial office has almost stopped lending to small firms, four traders in the region said.
"It is very troublesome and time-consuming getting L/Cs from Bank of China now and we basically have stopped trying," said an iron ore trader based in Shandong, adding traders who had failed to get credit had sold off iron ore stocks.
"Many iron ore traders will be wiped out this year and next due to the cut-off in credit."
Another trader said his company had failed to obtain an L/C from BOC's Shandong branch to book one cargo in May. The bank had "actually halted issuing L/Cs to small traders", he said.
A Bank of China spokeswoman did not reply to emails requesting comments. The Shandong provincial branch of the bank could not be reached for comment.
MARGINS FOR LOANS RAISED
Commodities such as copper, rubber and soybeans have been commonly used in China for financing, where traders or investors borrow against the commodity with the aim of investing the money in high-return areas in real estate or shadow banking.
Banks have been gradually cutting back loans to the steel sector since late last year, encouraging firms to increase iron ore imports as a way of getting financing.
Some banks are now requiring traders to secure buyers before they are granted L/Cs, and many have also increased the margins that importers must deposit at banks to 40-50 percent from 10-20 percent previously.
"We have currently stopped issuing new loans (for commodity financing) and are trying to get existing loans back. We've also stepped up internal supervision," said an official at China Construction Bank, who declined to be identified because he is not allowed to speak to media.
It was not immediately clear whether other state-owned banks in China had tightened approvals or had stopped issuing L/Cs.
Calls to a media representative of China Construction Bank were not answered, while a representative of Industrial and Commercial Bank of China did not respond to queries on the loan tightening measures.
Iron ore inventories at main ports were at a record 113.1 million tonnes at end-May, with about 34 percent owned by traders, according to data from industry consultancy Umetal. Inventories stood slightly lower at 112.5 million on June 13.
There is no official data on how much iron ore has been tied up in financing deals, but industry sources are concerned that any delays or defaults could prompt even more banks to scale back on trade loans, dealing a further blow to traders who are already cash strapped.
"We believe the next step of iron ore's transition will be a clearing out of excess inventory - a process that means purchasing activity needs to drop below real demand and is likely to result in near-term downside risk to prices," Graeme Train, an analyst with Macquarie, said in a research note.
Others were optimistic. Citi said in a note iron ore at $90 a tonne will lead to significant production cutbacks in China and elsewhere, which should help "prevent any sustained declines below $90 per tonne for the remainder of 2014". (Additional reporting by Manolo Serapio Jr. in SINGAPORE and Zhao Hongmei in BEIJING; Editing by Muralikumar Anantharaman)